Dustin's World of Finance and Economics

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Monday, September 26, 2011

(In)Famous hacking organization Anonymous is branching out into the world of securities analysis starting with their report on Chinese agricultural company Chaoda. Their public equity research arm is called Anonymous Analytics and their slogan is "Acquiring information through unconventional means." What their unconventional means are isn't explained but one can guess they incorporate their noteworthy hacking skills to assist in their research. I found this very interesting and was intrigued to read their report. All in all, I thought it was convincing, logical, and even entertaining. Reading a research report from a group that doesn't follow any securities industry standards and has no care for political correctness is refreshing and much more enjoyable. One may argue that they have no credibility or moral standards, but you can't argue with facts which is what they present in addition to their opinions.

Their thesis is that Chaoda Modern Agriculture, an HK$ 8.5 billion market cap company listed on the Hong Kong Exchange, is a fraud and will likely be delisted once the exchange investigates the company. The situation is very similar to the Sino-Forest case from early June. The report also implicates a shady marketing firm and perhaps some ignorant Ivy Leaguers. The report is a relatively easy read even for those not finance literate. Read and see if you think the company is a fraud or at least a terrible investment:Chaoda

Tuesday, September 13, 2011

Lately, there has been a lot of discussion on our forced participation into a supposed retirement safety net known as Social Security. Recently, Rick Perry made the claim that Social Security is a Ponzi scheme, a polarizing statement in politics that was further debated at last night's Tea Party Debate. First of all, Ponzi scheme has become a buzzword in our society ever since Bernie Madoff's "one big lie." What does it mean though?

Wikipedia's definition:

"A Ponzi scheme is a fraudulent investment operation that pays returns to separate investors, not from any actual profit earned by the organization, but from their own money or money paid by subsequent investors. The Ponzi scheme usually entices new investors by offering returns other investments cannot guarantee, in the form of short-term returns that are either abnormally high or unusually consistent. The perpetuation of the returns that a Ponzi scheme advertises and pays requires an ever-increasing flow of money from investors to keep the scheme going."

Many people may think that their Social Security deposits are put into a personal account that accumulates interest and then pays out at retirement. This is incorrect. Current expenses are paid by current revenues. This meets the first part of the definition of a Ponzi scheme as the "investment" outflows are financed by current inflows. Normally, there was plenty of revenue to cover the payouts as we had about 20 payees for every retiree. The excess cash was invested in special government bonds (indirectly financing our government's deficit spending). However, now we have about 3 payees for every beneficiary and are spending more than we take in. This meets the final part of the definition; that is, requiring an increasing flow of money from investors to keep going. Social Security (and Medicare) are an enormous liability going forward for the US and if not taken care of, our debt will grow exponentially (if we haven't defaulted by then).

There are no easy solutions to the problem and in our world of reelection over the long-term well-being of the country, it is almost impossible to deal with. Do we just end it now and tell older workers "We're sorry?" That would alienate the older voters who have had to finance other people's retirements but won't get their own SS checks; a sure way to not get reelected. Do we simply ignore the problem and take on more debt to finance it? This would surely lead to a rise in our borrowing costs and another downgrade. With so much focus on debt right now, I don't think someone could be elected who doesn't convince voters he's going to do at least something to curb the SS deficit. I think the path of least resistance to the problem is to convince voters that you're going to make sure older people are fully paid out and that somehow you will gradually and painlessly bring the costs under control. Of course, this is impossible, but we live in America where we get an A++ in kicking the can down the road and an A++ in ignoring math and believing in rhetoric. If you really believe we can and will lower the deficit caused by excess spending, please view this chart:

This chart only goes up to 2007. Guess where we're at now. $14.7 trillion or double where we were just 4 years ago. It is clear that we never have and never will rein in spending. This is mainly because we have the backstop of the printing press and the Fed to give us more dollars in case we run out and also because no one will get elected by taking away benefits from people. The end game is interest rates soaring when other countries refuse to lend to a country that engages in massive currency devaluation and hyperinflation and the question is when, not if. Being the ultimate can kickers, who knows when this will happen, but it is inevitable.

Thursday, September 1, 2011

I've been meaning to make a post explaining why any economic statistics reported by the government or other official entities are unreliable and basically just made up as I've alluded to in other posts. However, Peter Tchir of TF Market Advisors made a post today that can explain the farce that government statistics are much better than I can. Here he is:

One Death is a Tragedy, One Million is a Statistic

Another day of statistics, where the headlines are widely published, some details are somewhat explored, and in-depth analysis is next to nil.
The initial jobless claims number has become a farce. It is virtually statistically impossible for this many upward revisions unless the data is purposely under reported. I can understand the desire to smooth data, or make it seem better, but at some point the line of credibility is crossed. Not only do they screw with the main statistic, but they seem to use continuing claims as a secondary diversion. Last week’s 3641k continuing claims seemed statistically implausible, yet it was cheered. The doom and gloom crowd argued that it must be from people using up eligibility, in the end, it was just wrong by over 100k, according to today’s release. How is that possible?

Next we move to auto sales. It is hard to avoid hearing about auto sales today, probably, because the headline numbers seem good. I can almost ignore the fact that the first thing mentioned is the percentage change from a horrible period last year, but I am shocked the focus is still on total sales. Since at least 2005, the problem with car companies has been selling cars at a profit, not just selling cars. Nothing from the data indicates how profitable the sales are. So we can cheer this headline, but to a large degree it is meaningless. Then, making it more meaningless, is the fact that it includes fleet sales and is really based on sales to dealers. It doesn’t give a clear picture of how many cars were driven off the lot by bona fide, actual, human owners. If anything, the hype surrounding these figures rewards channel stuffing. There seems to be a degree of confusion by those spouting the numbers about the lack of follow through in the stocks. Maybe stocks have finally learned the lessons from these numbers, but it would be great if the masses were presented with details and useful statistics rather than just what the auto companies want to hype.

Then there was the ISM Manufacturing data. The sighs of relief from trading floors shook the buildings almost as much as last week’s earthquake. Where to begin with this data? It is a “diffusion” index. So it treats each respondent’s answer the same. It doesn’t matter if a company has 5 employees, or 5,000, their answer counts the same in the survey. If the often unreliable ADP report is correct that most of the hiring is occurring at small and medium companies, does that impact ISM?
If 2 small companies report better conditions, and 1 large company reports worse conditions, then the diffusion index would be 66, but the real world impact might be a lot different. Size does matter. Maybe that is part of the reason we see a discrepancy between regional surveys and the national survey? Does ISM report diffusion indices based on size? It would be interesting, at the very least, to see if there is a dramatic difference between big and small companies.

The next thing about the ISM methodology that I find interesting, is that the positive responses include positive responses and ½ of unchanged responses. I guess that is necessary to make a diffusion index, but I would like to see if it is realistic. Do “unchanged” responses have a tendency to follow the trend the following month? I could easily see someone who reported improving conditions one month being inclined to report unchanged the next month, even if conditions were actually worse. These are surveys done by people like you and me, well actually by people with “survey filler outer” included in their job description.

I’m not saying that having the data broken down more precisely would change the market reaction, but I don’t see why it isn’t available, and I don’t see why more analysts aren’t demanding that data. We can all look at a headline, but the value comes from those who can figure out what is going on behind the scenes. If there have been structural changes in the economy (and I believe there have been), then knowing more details would be helpful. The old rules of thumb may be deceiving us.

Of the 5 components, I am most confused by inventories. Inventory growth strikes me as highly suspect. I can see times where it is indicative of future economic growth as companies prepare for increased demand, but equally, it strikes me that it could represent a sudden slow down in final demand resulting in an unexpected inventory build. Had inventories remained unchanged, we would have seen a sub 50 print. You can’t convince me easily that inventory build last month was a positive indicator, yet that is what the headline would have you believe.

This is all in advance of tomorrow’s NFP report. NFP holds a special place in the dubious statistic category. First we have the fact that there are two separate surveys. We have the establishment and the household. The establishment survey is statistically significant for changes of 100,000; whereas the number is 400,000 for the household survey. In this day and age where virtually everything is done on the internet, I bet Google or Facebook could probably produce a more accurate report within a few months if either one bothered. Until that time, we are stuck with 2 sources of data, both of which have wide margins for error. Then we have the fact that for many months, the birth/death model generates more jobs than the headline itself. That wouldn’t be bad if it didn’t seem to require annual revisions lower. Once again the consistency of the annual revisions indicates that the reports are designed to produce numbers more positive than the reality in the hopes that by the time it is adjusted down, the market has moved on. Having said all of that, the market, or at least the analysts will try and distinguish between 40,000 and 80,000 when the difference is not actually significant or verifiable. They will latch on to whatever survey provides the most positive spin. Those who said the household survey matters more than the establishment survey, will find equally compelling reasons why it is now the establishment report that matters, or vice versa. Obama will be talking about jobs next week, so no matter what number comes up, expect it to be cited often over the next week.

I just realized, the president will be speaking about jobs and more handouts right before the start of the NFL season. Even Stalin might blush at trying to use bread and circuses so obviously.

And there you go. So while after doing some research, you may conclude that tomorrow's NFP numbers should be absolutely terrible; but, remember just how unreliable these numbers are and the people who create these numbers are. When trying to predict these numbers, (sadly) I think you need to take into account what the Fed/government wants. The Fed wants further easing and more and more FOMC members are becoming dovish and more dovish. The public sentiment right now seems to be that people are unsure if QE2 did anything besides raise food and energy costs (an easy argument to make when viewing the data). However, if the market happened to fall some more and became more tumultuous, the public would be more accepting of a huge program of easing.

So after all that, I am net short right now holding SPXU, DGP, and AGQ but I also have a lot of cash on hand not wanting to have too much risk. I'll make an arbitrary NFP number prediction here for fun: +23,000 on expectations of +67,000.

Sunday, August 28, 2011

This past week was another volatile one, but it seems the trading range is decreasing forming a pennant on the S&P 500 chart.

These formations are usually viewed as continuation patterns meaning that we will have further downside from here. This is definitely a possibility but after finishing the week up 4.7% and rallying on bad economic news, I'm bullish for the near-term. The week was capped off on Friday with revised Q2 GDP coming in at 1% on expectations of 1.1% and the much awaited Jackson Hole speech from Bernanke. The expectations were for him to just reiterate that the Fed is watching markets closely and will use any monetary tools they deem necessary. However, we got a little unexpected news when he said that the Fed's September meeting would be extended from one day to two days to have extensive talks on monetary policy. Initially, the market sold off as he did not confirm QE3 was coming, but then had a sharp rally. I think this rally occurred because people realized that an additional day of Fed meetings means it's more likely we are to get some kind of further easing (whether that easing is QE3 or Operation Twist, we will have to see). So, we got a sharp rally that held up the whole day even with Hurricane Irene approaching. Economic data continues to be weak and I expect that to continue, but markets aren't always rational and very well can rally for awhile.

The big headwind for the market continues to be Europe where things seem to be getting worse and worse. Christine Lagarde, the new head of the IMF from France, just endorsed using the European bailout fund (the EFSF) to assist banks with capitalization problems. This puts Germans in an awkward situation as they are the ones in the best financial situation and would be hurt the most by a further increase in the EFSF which would need to be substantial. $230 billion in government-guaranteed European bank debt matures in 2012 and needs to be paid for somehow because God forbid bank debt investors take a loss. Germans are growing weary of their sovereignty and financial stability slowly being drained and Europe is growing increasingly tense.

If Europe is quiet this week (or manages to stay out of the mainstream media), I think we rally up until Friday when we get nonfarm payrolls (NFP) and the unemployment rate. The unemployment rate is expected to come in unchanged and NFP is expected to decelerate to +75,000. I expect continued poor economic data and a miss in the NFP number, but it's always hard to predict these numbers since they are unreliable and manipulated.

Gold prices continue to be volatile and we got the margin hike this week that I was expecting. I sold my gold long on Tuesday morning when it looked like the parabolic rise was topping. Shanghai raised margins Tuesday and the CME raised them on Wednesday causing gold to sell off from about $1900/oz to $1750/oz. It only sold off for two days and is now rallying back hard. This volatility has me concerned that we will see another margin hike like we did with silver in May. To see what a series of margin hikes can do to prices, check out the chart of silver:

The first margin hike is indicated by the green arrow. We had a 2 day sell off and then continued higher. Then, another margin hike and some more and you see how margin hikes can manipulate prices catastrophically to the downside. Gold is acting the same way. View the gold chart below:

Green arrow indicates the margin hike

As you can see, gold is acting scarily similar and this is a cause for concern. If in gold, be ready to sell at any sign of a margin hike.

With so much volatility and downside risks, it still is a daytrader's market and that's how I'll be trading. On Friday, I rode the rally up via AMZN and sold at the end of the day not wanting to hold over the weekend. For risk-on days, I will be entering any high beta names that have bullish patterns. For risk-off days, I will simply trade via the 3x leveraged ETFs like TZA, EDZ, and FAZ. (If you want to know what I'm trading realtime, follow @Trader_Gator)

Volatility is the name of the game, so stay nimble and be cautious. Capital preservation is the most important right now, so don't get cute and don't be stubborn or ignorant.

Wednesday, August 24, 2011

Had to throw this into the blog. This is the economics that the government and idiots like Paul Krugman believe in.

This is why we are in so much debt. Public spending is not good. We are allocating resources (taxes) or printing money (inflation) to create jobs that the free market would not normally produce i.e. we are funding inefficient investments. This is how bubbles occur like the one we saw in housing in the last decade.

Today, the Congressional Budget Office, or CBO, released their ten-year outlook on how they think the budget will ebb and flow for the future. As usual, the government has extremely optimistic views on how the economy will fair for the next decade. For analysis, we turn to Bruce Krasting of http://brucekrasting.blogspot.com/. You tell me if you think the government if being a bit optimistic.

The Congressional Budget Office released their ten-year outlook for the US economy today. It is a very complex analysis. There are dozens of critical variables that go into this long-term report. A Base Line set of assumptions is put into a (very big) computer. The report makes projections on future debt levels.

This document is significant as virtually all other long-term federal budgets are built around the operating assumptions that CBO uses. Economists and politicians will use this report to push their own agendas. That is how things work.

My crystal ball is cloudy these days. I’m having trouble looking down the road past a week. I don’t have a clue what conditions will be like in five years. Neither does the CBO. But they have to produce this report and they have to make assumptions to do that. I think the variables were set at levels that are on the optimistic side. But I’m a pessimist so I’ll let you decide if these are reasonable assumption.

The most critical variable is GDP. The folks at the CBO see clear sailing and high growth for the whole ten years. Their average growth rate is ~15% higher than the previous decade. That is because of the big 08 recession. The CBO believes that won’t happen again. No "dip" in ten-years. There is no basis for that. The US has a recession every 5-6 years.

Another central assumption that drives the results is the rate of unemployment. According to the CBO happy days are right around the corner. Unemployment will fall to 5% in just a few years and stay at that level forever. We should be so lucky.
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With the drop in unemployment would come an increase in hourly earnings. At least that is how the CBO sees it. Note that the hockey stick of improvement is supposed to happen, well, about a six months ago. Maybe I’m not looking in the right places.

Inflation drives many components of the federal budget. I’m not sure what number to use. The CBO thinks it will be tame. Maybe.But I doubt it. We are in a ‘short’ resource world and the monetary authorities are pumping high-octane fuel. It would be helpful if the CBO were to stress test this at 4 or 5%. The results would be quite different.

There are numbers for the revenue and expense side. Once again, the CBO plugs in some rosy assumption about the direction of income and spending. Just about every arrow is pointing in the right direction.

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The bottom line from the CBO is that debt held by the public will rise from its current level of $10T to $14.5T over the decade. The good news is that the percentage of debt to GDP will fall from the current level of 67% to 61%. The conclusion is we’re headed in the right direction.

To do that the USA will have to hit the numbers that the CBO has set out. I see little chance of that happening. There’s too much ‘up-side’ built into the projections.

When S&P went to the White House and told them they were going to cut the USA’s AAA the Treasury Department went on the offensive. Tim Geithner led that charge and did his very best to convince the American people that S&P had it all wrong. That they were incompetent and did not understand the macro economic dynamics that drive our debt profile. Geithner used these CBO projections to make his case that the US was on a good track.

S&P said “No Sale” to that argument. Looking at the assumptions that Geithner relied on to make his case I don’t blame them.

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Remember, on Friday we get the 2nd estimate of Q2 GDP. It's expected to be 1.1% revised down from 1.3%. I wouldn't be surprised to see a sub 1% print.

Monday, August 22, 2011

Bloomberg came out with a comprehensive report on secret lending programs the Fed used from 2007 to 2010 last night. The most shocking thing about the report is the amount of money lent out to banks not only in the US but around the world: $1.2 trillion. As the Bloomberg article states, "Denominated in $1 bills, the $1.2 trillion would fill 539 Olympic-size swimming pools." Further, the $1.2 trillion is an even larger amount than the amount the government lent out in its Troubled Asset Relief Program, or TARP, which totaled $700 billion. The banks who received the most money are not surprising: Morgan Stanley, Citi, BofA. What is surprising is that the Fed found it necessary to bail out not only US banks but also foreign banks. In fact, RBS and UBS are both in the top 6 in peak amount borrowed. Also, many of the banks that received these secret loans were touting just how strong their liquidity positions were while receiving them! JP Morgan mentioned its "fortress balance sheet" at least 16 times while receiving secret loans peaking at $68 billion.

The Fed's stated goals are price stability and sustainable economic growth. So how does lending at below market rates to failing banks lead to either one of these? It certainly doesn't lead to price stability. As the below charts shows, food (something we all consume) prices are anything but stable. They are not only volatile but have a long term trend of increasing.

Higher food prices are due to the Fed printing money, and printing and lending to banks is of course inflationary.

So, maybe these loans have created sustainable economic growth then. Check out this chart of the S&P 500 priced in gold.

Why is the S&P priced in gold the most appropriate graph? Because the S&P in dollar terms includes increases due to the dollar being worth less. Like my previous post on gold, gold cannot be created out of thin air like dollars, so it has a stable supply. Another chart showcasing this economic (non)growth is the unemployment rate.

Even if you believe the government's made up numbers, the unemployment rate indicates anything but economic growth.

So, what did the lending program actually do? It gave banks who took excessive risks even more money to take excessive risks. In a capitalist society, rewards should come for performing and penalties for not performing. The Fed is distorting this and is rewarding those banks who took too many risks, who were not smart, and who directly hurt the economy more money to play around with. This is like the losing team in sports receiving a prize while the winning team receives nothing. These nonperforming banks are being encouraged to keep on doing what they've been doing and the Fed has etched in stone that we will continue having the same problems we have been of excess risk taking.